Financial Derivatives | STOCK OPTIONS: NOT A REPLICA

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Financial Derivatives (BST 254)

Coursework Assignment

2016

Task:

“…Black and Scholes (1973) treat stock options as redundant securities as their payoffs can be replicated in continuous time by investments in stocks and bonds. Thus, the existence of options markets should not have any impact on the market quality of the underlying stocks…” Discuss this statement and provide a critical evaluation of the relevant theoretical and empirical literature.

Required Length:

3500 words

Pass Mark:

50%.

Submission Deadline:

April 25, 2016.

Submission Procedure:

Coursework must be submitted by 12.00pm on the submission deadline. One copy mustbe submitted via TurnitinUKon Learning Central and one hardcopy must be submitted to the Postgraduate Hub. If you do not submit both copies then a mark of zero will be given. Notethat late submissions will also be given a mark of zero.

Some Advice:

You are advised that, in addition to the main body of the essay, you should include a cover sheet, an introduction (containing the aimsand objectives of your essay), a conclusion, and a full (and accurate) list of references.Furthermore, use double-spacing, the 12-point Times New Roman font (section headingsshould be in a larger bold Times New Roman font), and the Harvard style of referencing.Finally, before you submit the final version, check your spelling and punctuation andmake sure you have followed the correct conventions. Failure to heed this advice mayresult in a lower mark.

Please note that your word count should exclude the cover sheet and the reference list.If the number of words exceeds the requiredlength, the essay will be awarded a lower mark. Failure to supply an accurate wordcount will also result in a lower mark.A good starting point for your essay would be to read Chapter 14 of Hull (2012). Then,try to identify a relevant sample of academic papers (from good quality journals) uponwhich to base your essay. For a good collection of papers (including papers of a recentvintage), see the advanced search option in the JSTOR website:http://www.jstor.org/search/AdvancedSearch.OrSciencedirect website:http://www.sciencedirect.com/. Note also that working papers (prepublishedpapers) can be referenced; see the SSRN website for further details (www.ssrn.com).However, be cautious of using too many pre-published papers as their quality is more difficultto assess in comparison to papers published in high quality journals. The key is to base your essay on a good quality sample of the relevant literature.

Plagiarism:

In addition to the usual definitions of plagiarism (see the plagiarism booklet), any submitted essay that contains elements of work submitted as coursework by you for other modules will be treated as a case of plagiarism.

Dealing with problems within the group:

Member’s individual contribution to the group assignment must be included in the appendix. (Please note that the appendix does not form part of the word count).

If there are any problems within a working group, then students should write a brief email (no more than 150 words) to Khelifa Mazouz (mazouzk@cardiff.ac.uk) by 10thApril at the latest. At the discretion of the lecturer, the group may be called together to discuss these problems at a later date. If problems persist in the final days of the assignment, then students should submit a formal statement in writing. If this process reveals that there is a group member who has provided insufficient positive contribution to the assignment, then the right is reserved to give that student a mark below that of their group.

We also strongly recommend that you minute group meetings and make notes of who contributed what to the assignment.

Marking Scheme:

The following provides a guide to the marking scheme used to assess essay quality:

70 to 100% – Excellent Pass: An excellent answer should be outstanding in most respects.It should show an accurate grasp of the issues raised by the question and shouldconduct a sustained, coherent argument in a style that is fluent. It should demonstratean excellent knowledge and understanding of the literature, using relevant, recent, andhigh quality reference material.

60 to 69% – Good Pass: A good quality essay should have many, if not all, the featuresdistinguishing an excellent essay. The range of the discussion could compensate forsome weakness in style or some flaws within the argument. Alternatively, a well-written,thoughtful and well-researched essay could compensate for some limitations in the rangeof papers referenced. Essays in this class should contain little or no irrelevant materialand should be generally well constructed.

50 to 59% – Pass: A pass quality essay should give some evidence that the main thrust ofthe question has been recognised. However, recognition of issues may be incomplete, analysisand discussion could be restricted and there might also be a tendency to paraphrase.

Evidence may be unbalanced or of dubious relevance with a tendency to excessive generalisation or unsupported assertions of a subjective nature. This class is also appropriate where much of the content seems worthy of a higher grade but where poor organisation, syntax, etc., obscures the answer.

40 to 49% – Fail: A fail quality essay makes an attempt to answer the question but without fully understanding its implications. It may be characterised by insufficient evidence of familiarity with, or understanding of, the literature and/or issues under consideration.Such attempts as there are to develop an argument might only endorse or repeat a pointrather than supporting or extending it. The answer may also be descriptive with excessivegeneralisation, incoherent arguments and serious errors of expression.

Below 40% – Poor Fail: Work in this class fails to address the question convincingly and relies on a minimal range of detail, analysis, and/or referred material. It may be poorlystructured and planned, and might fail to provide sufficient evidence that the concerns of the course have been understood. Moreover, the essay may be marked by recurrent lackof relevance to the question and/or insufficient evidence of the student having studiedthe work set for the course. An answer that is obviously incomplete may also be classedin this category.

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Description

The above statement creates a notion that market quality of a stock cannot be influenced by the payoffs of the relative stock options since they are replicated in a continuous time. Therefore, the statement means that the payoff that will be derived from options has absolutely no effect on the all market aspect of its underlying stock. For instance, if you want to value stock ‘A’, whether the payoffs of its relative option is negative or positive, its value will not be affected. The above notion by Black and Scholes (1973) has been an invaluable talking point for many researcher (Buraschi & Jiltsov 2006; Ansi and Ouda 2009). The statement is concerned with the dynamic interactions between the stock and the options market. For many academic discussions that have been conducted in regard to these interactions dynamics, there seem to be divergent result (Ansi and Ouda 2009). While some of the studies will agree with the notion created by Black and Scholes (1973) that portray stock options as redundant securities, since their payoffs are replicated, others insists that that tat notion is untrue. For this assignment, we are going to determine whether stocks are indeed replica or not. Hence, this begs the question: Are stock options redundant?